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This chapter is from the book

Beggaring Thy Neighbors with a Chronically Undervalued Currency

  • China’s undervalued currency encourages undervalued Chinese exports to the U.S. and discourages U.S. exports because U.S. exports are artificially overvalued. As a result, undervalued Chinese exports have been highly disruptive to the U.S. and to other countries as well, as evidenced by trade remedy statistics.

    —U.S.-China Economic and Security Review Commission19

On the one hand, countries such as the United States and Japan as well as the European Union abide by “floating exchange rates” in which the values of the dollar, yen, and euro are determined in the free market. Thus, when a country such as the United States sees its trade deficit rising with either Japan or Europe, the value of the dollar will tend to fall relative to the yen and euro as dollars pile up in foreign banks.20 This weakening of the dollar makes imports into the United States more expensive and U.S. exports more competitive. In this way, free-market forces in the world’s currency markets help bring global trade flows back into balance.

China, on the other hand, has adopted a “fixed exchange rate system” in which it pegs the value of its currency, the yuan, to the value of the U.S. dollar.21 The result, as Chinese imports have flooded into the United States, has been a large undervaluation of the yuan relative to the dollar. The most reliable estimates put the size of this currency undervaluation at anywhere from 15% to 40%.

As a practical matter, China’s “fixed-peg” system means that no matter how big a trade deficit the United States runs with China, the dollar cannot fall relative to the yuan. This fixed peg also gives China a big advantage over much of the rest of the world—from Europe and Asia to Latin America—when it comes to accessing lucrative U.S. markets. Accordingly, China’s “beggar thy neighbor” currency policy is an important engine of its export-driven growth.

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